Looking Back At Last Week’s Mini ‘Flash Crash’ In Gold

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Looking Back At Last Week's Gold 'Flash Crash'

Hello fellow Slopers,

Reviewing last week's Slope posts, I noticed Gary Tanashian's bullish guest take on gold last Wednesday ("Why Gold & Why Now?"). Gary reiterated the long-term bullish case for gold in the wake of Tuesday's sell-off. In this weekend's FT, John Dizard's column on the sell off ("Gold flash crash rouses suspicions of witchraft") offered some support for the bullish case, to the extent that it suggested last Tuesday's shock likely wasn't a harbinger of another significant correction.

Dizard's columns are usually worth reading in full, and this one is no exception, but this was his argument in a nutshell: Dizard cited research by fixed income strategist David Goldman. who noted that gold and TIPS are both highly correlated, since “they are both deep out of the money options on catastrophic changes in the price level”; since TIPS didn't react nearly as strongly as gold on Tuesday, Goldman argued that indicated the sell-off in gold wasn't that significant.

Neverthless, for gold longs who want to hedge their bets, at the bottom of this post I've included a screen capture of the optimal puts to hedge the gold-tracking ETF GLD against a greater-than-20% drop over the next several months. Before that, though, a quick reminder about optimal puts, and a look at how the cost of hedging GLD fluctuated last Tuesday, before and after Bernanke moved the markets.

About Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor (available on the web and as an Apple iOS app) uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

Hedging GLD With Optimal Puts Last Tuesday — Before And After Bernanke

By coincidence, I happened to look at the cost of hedging GLD Tuesday morning, prior to the Bernanke excitement. I tweeted this from the Portfolio Armor account at the time:

Less than two hours later I noted that the cost of hedging GLD against a greater than 20% drop (from its then-lower price) had jumped more than 50%: